Last week was a poor week for equities. JSE listed equities underperformed their emerging market peers and the rand also weakened in sympathy (see below). The trade weighted rand lost about three per cent by the end of the week.
Somewhat surprisingly – given rand weakness that ordinarily implies more inflation to come – the market in rand denominated fixed interest securities, across the yield curve, had a very strong week. The forward rate agreements offered by the banks moved sharply lower (and bond prices higher) implying, in the market’s view, that there was no chance of an increase in the repo rate over the next 18 months.
The yield curve represented by the zero coupon bonds also moved sharply lower beyond six years’ duration – by over 40 basis points. The implication of this move is that the RSA one year interest rate, while still expected to move higher over the years, is now only expected to breach the 7% level in 2020.
Consistently with these moves lower (in actual and expected interest rates), inflation expectations have declined. These expectations are implicit in the difference between vanilla RSA bonds that are exposed to the risks of higher inflation and the inflation linkers that are fully protected against inflation. This measure ofinflation expected, or more literally compensation for bearing inflation risk, is given much attention by the Reserve Bank. The argument is that inflation expected causes inflation itself, for which incidentally there is little evidence. The feedback loop is from higher inflation to more inflation expected, not the other way around. This measure of inflation expected has remained stubbornly and very consistently above 6% for much of the past few years. That it declined last week will be welcome news to the Reserve Bank and provides further strength to the argument being reflected in the money market that the next move in the repo rate is down rather than up.
The one consolation in the weaker rand is that it is being accompanied by consistent weakness in commodity prices. Generally a trend from which precious and other metals as well as oil have not escaped, so implying less inflationary pressure.
It is the weakness in commodity and metal prices and in emerging equity markets that have weighed on the rand and other emerging and commodity currencies. As we show below, the rand has made some small gains against the Aussie dollar and the Brazilian real since early March, though it did weaken marginally last week.
For global bonds, including the RSA bonds, the commitment to extraordinary money supply growth in Japan and the intention to weaken the yen, brings about the so-called yen carry trade. The difference between interest rates in Japan and almost everywhere else is thus a primary reason for downward pressure on global interest rates. Borrowing in yen and buying rand denominated securities was a poor trade in the first week of April, but a much better one over the past two weeks, notwithstanding the weaker rand against most currencies last week, the yen excepted. Brian Kantor
thanks for this and all the articles.